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August 7, 2012

Savvy Advisors Are Turning to ETFs

The popularity of the ETF as an investment vehicle continues to grow, with 1,250 U.S. ETFs holding $1.1 trillion in mid-2012, according to State Street Global Advisors. Mutual funds still hold the greatest amount of assets from advisors, about 40%, according to the latest AdvisorBenchmaking report. But ETFs represent the next-highest amount, around 14%, and it appears as though those percentages may continue to narrow. Since the beginning of 2012, investors have pulled almost $15 billion from U.S. stock funds, while boosting money put into ETFs by $16 billion, according to industry studies.

Much of the growth in ETFs is due to advisors’ using them to help clients efficiently and cost-effectively take advantage of investment opportunities around the world in the equity, fixed income and alternative investment markets. ETF asset growth is lately also benefiting from growth in the types of ETFs, for example, equal-weighted products, those with a fixed-income target maturity similar to a bond ladder, and actively managed ETFs.

Encouraged by the slow but measurable improvement in the economy, most advisors appear willing to use ETFs to implement at least a portion of their clients’ portfolio strategies. In the latest AdvisorBenchmaking report, for example, 54% of advisors say they are likely to increase their use of the ETFs in the near future, with 43% saying they expect their use of ETFs over the next three years to remain the same.

According to the latest AdvisorBenchmarking report, advisors continue to be drawn to ETFs mainly because of their fees. The expense ratio of many ETFs is usually well below that of a similar-strategy mutual fund, and for some ETFs the cost is only a few basis points. Because ETFs trade on an exchange like a stock, investors can buy and sell ETFs without causing the fund manager to raise cash to meet redemptions, as in a mutual fund, thus avoiding a taxable event.

Specific benchmark exposure is also appealing to advisors, which is understandable, since many were not accessible to retail investors until ETFs came along. Today, the most popular ETFs usually track broad indices, but there is an ETF for most every asset class, if not every sector and sub-index. From the most remote geography to the least familiar commodity, an ETF is seemingly available.

ETFs also offer transparency in holdings and operations. Advisors can often see what stocks or other instruments an ETF is holding on a daily basis, and the actions of authorized participants whose job it is to create and redeem ETF shares at any time, as market conditions warrant, help ensure that ETF market prices will closely reflect the value of their underlying holdings. Moreover, ETFs publish their calculation of an ETF’s intraday market value based on the current price of the underlying securities. The indicative intraday value, as it is known, has its own ticker and is updated and published continuously throughout the trading day.

What is the strategic role of ETFs in portfolios? According to the survey, many strategies lie behind ETF implementation. While “core” and “sector” exposures were most common, several other approaches were all within a few points of each other, including: alternatives exposure, directional market positions, factor or asset class exposures and country/region exposure. Clearly, ETFs are providing advisors and investors with attractive options for expressing their views, and that is translating into strong, consistent growth for these vehicles.

ETFs and mutual funds are likely to continue to be the leading vehicles where advisors put their clients’ money, and in certain circumstances, one may offer an advantage over the other. But ETFs have proven to be a force, and savvy advisors will ensure that they have a prominent place among the tools used to help clients achieve their investment objectives.

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AdvisorBenchmarking is a research and analysis center focused on the registered investment advisor (RIA) marketplace. Study results quoted in this article are based on the 300-plus RIA firms that took the online survey in March-May 2011. The service is aimed at helping advisors grow and enhance their firms by comparing how their businesses fare against other advisors. Advisors also learn best practices of the most successful advisors in the business.

AdvisorBenchmarking is an affiliate of Guggenheim Investments. The analysis on AdvisorBenchmarking.com is based on the number of completed surveys and reflects only information from those surveys. This information is intended to be general in nature, and these overviews are no substitute for professional, legal or consulting advice. This information should not be construed as advice from Guggenheim Investments or any of its affiliates.